a. The main objective of this topic is to be able to distinguish between publicly and privately owned corporate issuers. It is worth mentioning here that most students confuse publicly and privately owned corporate issuers with public and private limited companies.
b. Publicly owned companies are those whose shares are listed and traded on stock exchanges. Most private companies are privately owned. However, some public companies may also be privately owned if their shares are not listed on stock exchanges. Therefore, private limited companies are privately owned. However public limited companies may be privately owned or publicly owned depending on whether they have their shares listed on stock exchanges.
c. The classification of a corporation as publicly and privately owned corporate issuers is determined by the following three factors:
c.1. Exchange listing, liquidity, and price transparency;
c.2. Issuance of shares;
c.3. Registration and disclosure requirements.
1.1. Exchange Listing, Liquidity, and Price Transparency
a. Publicly owned corporations are usually listed on the stock exchange. This aids frequent transfer in ownership of the shares. And since the shares are divided into very small units, any investor who is willing to make only a very small investment can also easily purchase and sell the shares.
b. However, for privately owned companies, the shares are generally not listed on the stock exchange. The shares are purchased through private placement memorandum (PPM). The transfer of shares is also a very cumbersome process. The seller must find a buyer for the shares. And then only if the company agrees, the transfer of shares can take place.
c. For the listed companies, the pricing of the shares is also transparent. It is usually the current trading price. This helps the investors to track the value of their investments as it changes.
d. The price of shares of privately owned corporations are not as transparent. This is mainly because, the buyer and seller must agree on the price at which the share can be traded. This also makes the valuation of investment difficult.
e. Privately held corporations, however, also have some benefits. Some of them are:
e.1. They provide better accountability of its stakeholders. Since there are a very few numbers of shareholders, the management and controlling shareholders are more accountable to the minority and other shareholders.
e.2. Since most privately owned corporations are early-stage companies, they offer huge return potential to its investors. (However, on a downside, the risk on investment is also high).
e.3. There are fewer disclosure requirements for the privately owned companies. For example, the requirements that are a part of listing of share on stock exchange are not applicable for the private companies.
e.4. Since these companies are not required to make quarterly disclosures, they do not have to worry about the quarterly profit figures. So, they are not required to resort to measures to improve only short-term profits. They can focus on long-term returns.
1.2. Share Issuance
a. Public companies can issue additional shares in capital market though IPO or underwriters. And then these shares can be traded in the secondary market or stock exchanges.
b. Private companies, on the other hand, issue shares through private placements. The terms of these placements are generally stated in the legal contract document. Public companies may also make private placements of their shares subject to the regulatory constraints in their respective jurisdictions.
c. Investments in privately owned corporations can be only made by accredited or sophisticated investors. These are the investors who have high appetite for risk that doesn’t need regulatory approval and oversight.
1.3. Registration and Disclosure Requirements
a. Public companies are required to register with a regulatory authority. For example, in US the public companies are required to register with SEC (i.e., Security and Exchange Commission). And SEC oversees and regulates these companies to make sure they are following fair practices.
b. The public companies are also required to make certain disclosures which includes annual reports, quarterly reports, proxy statements, and additional disclosures regarding proposed mergers, acquisitions, tender offers, transactions by company insiders, details if the beneficial ownership exceeds 5% of outstanding shares, etc. Such information may affect the share prices of the company. The main purpose of these disclosures is to protect the interests of investors. These disclosures are available to the public on SEC’s EDGAR (Electronic Data Gathering, Analysis, and Retrieval) system.
c. Private companies are not required to make all these disclosures as required by the public companies. However, they are required to file annual returns, and in most cases the audited financial statements. And they are not required to make all the information publicly available.
d. However, if private companies want, they can disclose important information directly to their investors, but they are not obliged to disclose it. They will do the same if they wish to raise capital.
2. How can a private company go public?
There are three ways through which a private company can go public. They are:
a. Initial Public Offering (IPO)
b. Direct Listing
c. Acquisition
2.1. Initial Public Offering
a. Private companies can apply for IPO after meeting its basic listing requirements. There are some basic listing requirements regarding bid price, outstanding shares, lot size, market capitalization, total assets, etc.
b. An IPO also requires an investment bank to underwrite the issue of existing or new shares.
c. If the IPO goes through the company goes public and can be traded on exchanges.
d. The IPO proceeds can be used by the issuing company as capital.
2.2. Direct Listing
a. A direct listing is the process by which a private company goes public by selling its outstanding and existing shares to individual and institutional investors.
b. Companies wishing to list on a stock exchange do not require the assistance of underwriters, investment banks or broker-dealers throughout the process and there are no lock-up periods.
c. Direct Listing is a very fast and cost-effective way of issuing shares to the public.
2.3. Acquisition
a. A private company can become public if it is acquired by a public company.
b. Sometimes this acquisition is undertaken by a special purpose acquisition company (or SPAC) often known as a “blank-check” company.
2.3.1. What is a SPAC?
a. A SPAC is a shell company, mainly floated to acquire a unspecified company at a future date. It is important to note that the investors in these companies do not know the company it will be acquiring, since the company being acquired is unspecified. Investors can only guess about the company being acquired through the background of the executives and their media comments.
b. The money or capital is raised by a SPAC through IPO.
c. The proceeds of capital raised through IPO are put in a trust account.
d. This money is only used to purchase the private company for which this SPAC is floated.
e. If the acquisition is not completed within specified time (usually 18 months) the money is returned to the investors.
f. Once the purchase/acquisition is complete, the private company becomes public.
3. How can a public company go private?
a. For a public company to go private, the investors must acquire all the publicly traded shares or the shares trading on the exchange and delist the company from all the exchanges.
b. To go-private the investors have to pay a premium over the current trading price of the stock.
c. The investment required to purchase the publicly traded shares is often raised through debt.
d. There are usually two ways in which a company may go private: Leveraged Buyout (LBO) or Managed Buyout (MBO). Under LBO, the buyout is financed using debt, while in MBO the investors use their money for buying the shares.
e. Investors mainly decide to go-private if they expect the valuation of the company after acquiring the shares at premium will be more than the price paid for the acquisition.
f. Usually, the going private of a company is accompanied by the structural changes such as changes in management, restructuring of assets, etc. Furthermore, going private also puts the remaining investors in greater control, and the company that has become private is now under lesser scrutiny of the overseeing authorities.
g. The company that goes private can also go public after some years, after the desired objective of the investors is achieved.
4. What are some of the major trends in private and public companies?
a. If we look at the data, in developing countries, the number of public companies is increasing. This is mainly because these economies are often characterized by high growth rates, a transition to an open market structure, and attract a good amount of capital inflow.
b. On the other hand, the markets of the developed economies are more mature. These economies have witnessed a high number of mergers and acquisitions. This has resulted in a smaller number of publicly listed companies on the exchange. These economies also have greater access to private equity and venture capital firms which can provide greater capital at a lower cost. Besides, a lower compliance and regulatory cost also makes private corporations a better alternative. Hence a lot of corporations tend to go-private in developed economies. Further, going private also helps avoid excessive control by top executives controlling the corporation.
5. What are major types of corporate owners?
a. Anyone holding shares of a corporation is deemed as the owner of that corporation.
b. Major category of owners of a corporation include:
b.1. individuals,
b.2. institutional investors,
b.3. other corporations,
b.4. government,
b.5. non-profit corporation, etc.
c. We will now discuss some of these owners in detail here.
5.1. Government
a. Government corporations are created with different levels of ownership by the government and other entities. For example, the government entities may be wholly owned by the government, or with some investment from other entities such as individuals, institutional investors, other corporations, etc.
b. Such (government) corporations have regular structures like other corporations, consisting of board of directors, management structure, etc.
c. These corporations, like other corporations also have compliance and reporting requirements. The main purpose of these requirements is to provide transparency in reporting to the external investors. Since government has a holding in these corporations, it is financed from taxpayer’s money. The auditing and other requirements make sure that this money is put to right use and towards right objectives. For other investors, these requirements make sure that this corporation is meeting its profit and loss objectives.
d. In most countries these corporations are set up to provide public goods and infrastructure facility. For example, in most developed countries government corporations are set up to provide facilities such as postal services, transportation services, etc. In emerging economies, they are also created to provide basic commodities and meet energy needs.
e. In some countries, financial institutions like banks are also initially set up as government corporations and are later transferred to private sector.
f. Some of the reasons behind privatization of government corporations is industry deregulation or technological changes. For example, in most countries telecom and power industry shifted from government to private hands due to high level and speed of technological changes.
5.2. Non-Profit Corporation
a. Corporations are also formed as not-for-profit companies.
b. These corporations are set up with non-financial social objectives, along with the financial objectives.